Car crash companies set for recovery
Posted on November 13, 2007 by Richard Beddard
Filed Under Companies, Investing, Naked PE |
According to Dr Keith Anderson’s Naked PE ratio, the cheapest six companies listed on the stockmarket include two companies in the auto industry. All six look like they’ve been in a crash.
Every three months I bring you the cheapest six stocks on the market fresh from the spreadsheets of Dr Keith Anderson, a lecturer at Durham University and expert in the price earnings ratio.
This October, Wagon heads the list. It designs and manufactures car bodies, doors and windows. Autologic, which distributes vehicles on behalf of their manufacturers (think double-decker car transporters), is in second place.
Instead of dividing the price by last year’s earnings per share, Keith divides it by the eight-year average of earnings per share. By comparing the 8-year PE with the normal PE in the table below you can see how it changes an investors’ perspective of a company’s valuation. Since we’re dividing the price of a company’s shares by the company’s earnings (or profit) per share, the lower the PE, the cheaper the share in relation to its recent earning power.
| Company name | Price | Cap (£m) | PE | 8y PE | Naked PE |
| Wagon (WAGN) | 23 | 27 | 11.5 | 1.1 | 2.1 |
| AutoLogic (ALG) | 68 | 42 | 7.2 | 2.3 | 2.3 |
| Johnson Service (JSG) | 68 | 40 | 2.5 | 2.3 | 2.3 |
| SMG (SMG) | 27 | 86 | 9.0 | 3.9 | 3.4 |
| Taylor Wimpey (TW) | 202 | 2,197 | 4.4 | 5.5 | 4.0 |
| Trinity Mirror (TNI) | 335 | 982 | 7.4 | 7.7 | 4.1 |
*NB: Prices are Friday’s closing prices
Looking at longer periods of earnings isn’t new. The father of value investing, Benjamin Graham, advocated using at least five years of data to prevent an exceptionally good or bad year from skewing a company’s valuation.
What is new is the additional statistical adjustment Keith makes to the PE ratio for the size of the company, and its sector. It’s calculated in the final column of the table above, and results in the Naked PE*1.
Keith’s testing shows that investing in the companies with the six lowest Naked PE ratios in 1975, and rebalancing the portfolio every year so it always contains the lowest Naked PE shares, produced an average annual return of 39% to 2004 including dividends, enough to turn £100 into nearly £1.5m.
The difficulty for investors is that in focusing on companies with very low prices, the Naked PE picks out companies that are extremely out of favour and quite probably in some sort of difficulty. The suffix ‘re’ as in ‘refinancing’ and ‘restructuring’ peppers recent statements from Wagon and Autologic.
SMG, the Scottish broadcaster and programme maker announced last week it is to raise £95.1m in a rights issue to pay off debt, and it’s trying to sell or float-off Virgin Radio to raise cash. Johnson Service Group, which supplies and cleans uniforms and work wear, is in talks with banks after failing to sell-off three non-core businesses.
Taylor Wimpey and Trinity Mirror are in highly uncertain sectors, house building and newspapers, and, like Johnson Service Group, Trinity Mirror has taken some of its regional newspapers off the market because it can’t find buyers willing to pay an acceptable price.
So the Naked PE probably works best as a screen for investors seeking out recovery situations. Companies with long histories of profitability suffering temporary set backs. The good news is, Keith’s back testing shows that companies on very low Naked PEs rarely go bust*2, and the rewards are high for the brave.
The bad news is the prices of some of these companies are in free-fall, and buying could leave you sitting on a loss, especially in the short-term. Even if the events that prompted investors to sell-off these stocks are history, sentiment can take years to turn-around.
When managing his own investments. Keith’s timing is less scientific than his method of stock selection. He prefers not to jump in during major sell-offs but wait months, or even sometimes years. Which it is, depends on the company and the actions of other investors.*3
Footnotes:
- See: The cheapest six stocks on the market
- Although, as we discovered three months ago, it can happen
- For more see Chasing 39% profit a year
- For the academic paper describing Dr Anderson’s work, see his Naked PE site
- Keith owns shares in Autologic.
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